Imation Corp. Q1 2008 Earnings Call Transcript

| About: Imation Corporation (IMN)

Imation Corp. (NYSE:IMN)

Q1 2008 Earnings Call

April 24, 2008 10:00 am ET

Executives

Bradley Allen - VP, IR

Frank Russomanno - President and CEO

Paul Zeller - VP and CFO

Analyst

Mark Miller - Brean Murray, Carret & Co.

Glenn Hanus - Needham & Company

Matt Teplitz - Quaker Capital Management

Operator

Good day ladies and gentlemen and welcome to Imation announces the First Quarter Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions).

I'd now like to introduce your host for today's conference call, Mr. Bradley Allen. You may begin, sir.

Bradley Allen

Thank you Kevin. Good morning everyone and welcome to our Q1 call. I just want to remind everybody that any information that we discuss today that is forward-looking in content falls within the meaning of the Private Securities Litigation Reform Act and all risk factors that could mitigate those outcomes are outlined in our SEC filings as well as our press release.

Let me now introduce Frank Russomanno, Imation's President and CEO.

Frank Russomanno

Good morning and thank you for joining us. Before I discuss Q1 highlights and turn the call over to Paul, I'd like to encourage all of you to vote your proxy for our annual meeting of shareholders to be held on May 7th at the Hotel Sofitel in midtown Manhattan. You are all certainly invited to attend as well and I hope to see many of you there.

Let me first say, overall we are pleased with our Q1 earnings in the face of challenging economic conditions. In particular, we are pleased that our gross margin improved over two percentage points compared with Q4 even on seasonally lower revenues.

In addition to improvement in Flash gross margins, we saw improved gross margins in Optical products as our recent acquisitions have increased our market position and relevance. Our restructuring actions in manufacturing also benefit gross margin as did product mix. These factors helped offset declines in our legacy magnetic tape formats.

Revenue growth in the quarter was driven by our strategic acquisitions of the TDK Recording Media business and Memcorp, as well as currency benefits. While our legacy tape business is a solid source of profitability and cash flow, we have recognized for some time that magnetic tape in and of itself is not a growth engine.

However, we do see growth opportunities in the commercial market in general with new product offerings such as Flash products, for example our SSD offerings and by extending our product line of CE products into new and existing B-to-B channels such as Office and eTailers.

In Q1 we saw softening demand from some of our enterprise tape customers in the financial services sector both in the US and in Europe. That sector has gone through significant turmoil recently as you know. Every year we invite our largest data center customers to get together for several days to meet with our OEM partners and with us. We just finished our End User Council meeting last week and based on the conversations we had there, it appears that their budgets remain in tact but discretionary spending was clearly curtailed in Q1.

In Optical products, Europe was down year-over-year despite positive currency benefits due to the decline in our Global Data Media joint venture which is mostly in Europe. It is early in the year. However, we also saw some softness in two key markets for Optical products, Germany and Russia, due to the market conditions and possibly a loss of focus as we enter the critical stages of our integration activities in Europe.

This past quarter, we saw the end of the format war for advanced optical with Blu-ray coming in on top. We believe this clarity should accelerate the growth of advanced optical media and we look forward to competing for this business.

We also experienced a loss in Electronics Products, which is the name of the former Memcorp business, in a seasonally softer Q1. However, we expect the Electronics Products segment to pick up in a seasonally stronger Q2 as we extend our geographic reach and add new accounts such as Wal-Mart Mexico. We remain confident that this acquisition will add significant value.

As expected, our Flash sales declined as we continued our previously announced rationalization of our US consumer Flash business. Let me remind you that at the end of Q3, we announced we would change how we participate in the USB Flash market, no longer offering price protection, temporary price reductions or consignment inventory.

As a result, we have lower USB Flash sales but better margins. We have improved our ability to participate profitability in the business. We are more selective about the business we go after. We are managing it differently and we have changed our stance in the Flash market both in retail and with the introduction of the solid state disc product.

The results were very positive in the first quarter where we saw much improved gross margins in these products. Having said that, we recognize that the Flash market remains a highly volatile and always changing business and we will manage our participation carefully.

Imation has a history of sizing our structure to the business reality and a culture of disciplined cost control. That legacy of discipline continues even now that we are on track, making investments in our brand strategy after years of restructuring the company and divesting operations.

Operating expense control remains a key focus for my management team and me to ensure that we invest wisely and as necessary to build the business but do so in a deliberate and disciplined way.

One last point about Q1, I believe our Q1 results offer a strong proof point on the resiliency of our business. In the face of difficult business and economic realities we faced during the quarter, we delivered earnings in line with our plan. The diversified nature of our business across multiple products, brands, channels, and regions provided us the ability to compensate for challenges in other parts of the business.

Finally I want to make some comments about our transformation. On May 22nd of last year, we laid out our vision for Imation to become a brand and product management company with a balanced portfolio of successful businesses in both B-to-B and consumer.

This transformation will take time to fully complete. This transformation also needs to occur across our four interrelated dimensions simultaneously. The first of these dimensions is strategy. The second is organization or culture. The third is skill sets and the fourth is execution.

Let me give you an update of where I think we are on that journey. Strategy, we developed our vision and a clear, straightforward and actionable strategic direction based on where Imation was after the Memorex acquisition and based on answering three questions.

Is the vision real? Is it achievable? Is it worth it? In other words, can it create shareholder value? We firmly believe the answer to all three questions is yes and our results to date are encouraging.

Organization and culture, with the acquisition of Memorex, we began to move beyond divesting and surviving to investing in profitable growth. The organization needs to move quickly, see successes and grow confident in our direction.

We have identified a few initiatives that we believe will generate visible results and profitable growth over a relatively short time horizon. We have put some of our best people on these initiatives and committed the resources needed to succeed with explicit metrics and benchmarks. This is a relatively recent effort and I will keep you updated as we progress.

Skill sets, last May, I described the re-skilling effort necessary to make our transformation successful whereby we would strengthen our marketing structure, complimenting our B-to-B heritage and existing skill set. Over the past 12 months we have brought on more than 40 new marketing executives from outside Imation either through acquisitions or through external hiring. They all come with strong brand building and consumer marketing experience.

In addition, we have redeployed employees internally to build out our marketing capability. These resources are in place now and integrated into the company and their presence should start to become more evident over the year.

Finally, execution, the best strategy in the world is no good if the organization cannot execute. I wanted to create a shared vocabulary and have a shared conversation around the company about creating a culture of execution that is focused on results.

I took a very practical approach by sharing with employees a book called 'Results'. This book contains very clear and practical descriptions of different cultures and enablers and impediments to creating a results focused organization.

We implemented a simple survey tool globally that profiles our corporate DNA and have now begun the discussion in earnest about how to align the organization top to bottom with our direction. I was encouraged by the survey results and am encouraged by the response of our employees globally who continue to impress me with their business maturity, resilience, and passion for the business.

In summary, we are pleased with our earnings in the quarter in light of a difficult economic environment. We are pleased with the progress of our transformation and confident we are pursuing the correct and most value creating strategy for Imation and finally, we remain committed to our financial targets for 2008 even as we remain watchful of the economic environment.

I will now turn the call over to Paul.

Paul Zeller

Thanks Frank and good morning everyone. As Frank mentioned, we had some difficult economic realities to deal within the quarter, especially in our enterprise class of customers. In spite of these challenges, we delivered solid earnings and very strong cash flows. We feel good about the start to the year and are intently focused on continuing to deliver on our commitments. There were a number of moving parts to our results in this quarter so let me get right into the details.

Our revenues totaled $530.9 million in the first quarter. That represents year-over-year growth of nearly 26%. Revenues from TDK and Memcorp acquisitions were the key drivers. They added about $163 million in revenues, $137 million from TDK and $26 million from Memcorp. If we exclude the impact of those acquisitions, revenues were down almost 13% and there were three main factors in that decline.

First, our magnetic tape business was down more than we expected as we saw softness both in the US and Europe as Frank discussed earlier.

Second, our European Optical results were down, driven by our Global Data Media joint venture. You may remember a portion of Global Data Media revenues in the past were for the TDK brand.

Now that we've completed the acquisition, those revenues are no longer inside of Global Data Media but directly in our results and in the numbers I just mentioned for the TDK acquisition. So in effect this overstates the benefit from the acquisition and understates the revenues in the base business.

Finally, Flash revenues were lower due to our planned rationalization of our exposure to the US regional channel as we discussed in previous quarters.

We saw volume growth in the quarter of 29% due to TDK and Memcorp. The overall weakness of the US dollar increased the dollar equivalent of our international revenues, adding about 5% to the worldwide year-over-year revenue growth. These volume and currency benefits were partially offset by an 8% impact from price erosion, which was in line with our expectations.

Total Optical product revenues increased 36% to $261.6 million, driven by TDK brand revenues from the acquisition. In total, Optical products represented about 49% of revenues for the total company in the quarter.

Magnetic product revenues increased 10% to $178.1 million due to the addition of TDK revenues, the majority coming from audio/video products. Total magnetic media represented about 34% of total revenues.

Accessory and other revenues totaled $38.5 million. That's up 24% from last year again driven by TDK, but also by modest growth in Memorex brand accessories. Accessories represented 7% of revenues.

Revenues for our Electronic product segment totaled $25.8 million with an operating loss of $2.7 million. Given the seasonally soft first quarter for this business, we had anticipated a loss. This business is now a segment from a reporting standpoint and is allocated a portion of corporate costs as well as acquisition, intangible amortization expense, both of which added to the loss.

Flash product revenues totaled $26.9 million and declined nearly 25%. This decline was in line with our expectations given our actions in US retail and Flash products represented 5% of revenue in the quarter.

On a regional basis, our Americas region revenue totaled $215 million in the quarter. That was flat with last year. The addition of TDK and Electronic products revenues from the acquisitions was offset by both magnetic and Flash product declines.

European revenues grew 23% totaling $176 million with TDK revenues partially offset by Global Data Media and soft magnetic revenues as I talked about earlier. Asia Pacific revenues were quite strong at $114 million, up 78% over last year, driven by TDK.

Gross margins were up 2.1 points from the fourth quarter and at the highest level in a year. You may remember our comments last quarter about fourth quarter being a particularly strong revenue quarter for consumer electronic products. That was not the case as expected in quarter one and we saw a positive impact on our gross margin percentage with our manufactured tape representing a greater percent of the mix in the quarter.

In addition, we delivered solid improvements in both Optical and Flash margins. In the case of Flash, this came as a result of our decision to change our strategy. The critical element of that strategy change has been to focus more intently on higher margin opportunities and to back off on higher risk business especially where consignment inventory is a requirement and where price protection is a risk.

As a result, we've not only rationalized our US retail participation where we're out of most accounts at this point but we have actively rationalized certain SKU's and accounts elsewhere.

As we implemented these steps we also focused even more intently on those opportunities where we have a strong margin. Especially for example, in our commercial channels where our margins are much better and they were especially so during the quarter. This strategy appears to be working. We had our highest Flash gross margin in almost two years.

In Optical, we benefited from a couple of factors. First, we saw improved sourcing costs coming out of last year end combined with a relatively stable pricing environment into our channels during the first quarter. Second, we initiated a global SKU reduction program to eliminate low or negative margin business.

As a final comment on our gross margin performance overall. Though the impact is difficult to measure precisely, we do believe our margins benefited from the weaker dollar in the quarter. On a year-over-year basis, our gross margins were down eight-tenths of a point.

Given the year-over-year mix penalty we're facing with a loss of higher margin legacy tape products, we were very pleased with this result with benefits coming from multiple categories as I just mentioned.

R&D costs were $6.6 million for the quarter, lower than prior periods but in line with expectations due to cost savings from the previously announced restructuring programs.

Selling, General and Admin expenses in the first quarter totaled $71.9 million, essentially flat with the fourth quarter. All else being equal, we would have expected to see somewhat of a decline in SG&A from the fourth quarter due to the seasonally lower revenues. There were several reasons why this was not the case.

First, the general weakening of the dollar vis-à-vis other currencies increased the dollar equivalent of our international spending. Next, the first quarter included performance based compensation expenses, which were not included in quarter four last year given our disappointing results in the prior year.

Finally as I mentioned last quarter, our 2008 full year outlook assumed approximately $15 million of incremental spending for integrating the acquisitions as well as costs associated with building our brands globally. We did see some portion of those costs impacting our first quarter although at a lesser rate than we'll likely see later in the year.

Having said that, later in the year we also expect to see more of the synergy benefits from our acquisition integration work especially in Europe and Japan. So all things considered, we expect to see improvements in our SG&A spending in dollar terms and as a percent to sales as the year progresses and we complete those actions.

Our worldwide employee count ended the quarter at 2,130, down about 5% or 115 employees during the quarter. That decline was driven by actions associated with our manufacturing restructuring as well as acquisition integration.

Restructuring and other charges totaled $700,000 in the quarter with the restructuring charges partially offset by an adjustment to our previous goodwill write-off. The restructuring charge was a gross $2.7 million, part of our previously announced program. Offsetting this we recognized a $2 million gain as we adjusted the goodwill impairment charge we took in the fourth quarter due to a settlement of the net asset adjustment process related to the TDK acquisition.

We continue to expect the total restructuring program to be in the range of $35 million to $40 million when completed including the last $4 million to $6 million of restructuring and other charges in 2008.

Total operating income in the first quarter was $19.5 million including the net $700,000 charge I just mentioned or $20.2 million excluding it. This result was generally in line with our expectations for the quarter.

Non-operating costs for the quarter totaled $1.2 million, down from the $3 million we recorded in the fourth quarter where we had experienced much higher currency losses. Versus the same quarter last year, we experienced a $2.7 million negative variance in non-operating due primarily to lower interest income on lower cash balances this year.

Our reported income tax rate of 39.9% was higher than typical due to the tax treatment of items in the restructuring and other categories. The tax rate on income excluding those items was approximately 34%. Earnings per share on a reported basis was $0.29 and excluding restructuring and other items, our earnings per share was $0.33 and in line with our expectations.

We started the year with a very strong cash flow result. Cash from operations totaled $32.8 million compared with $6.2 million in the first quarter of last year. This strong result came on top of the $74 million in operating cash flows we generated in the fourth quarter. Thus we generated nearly $107 million in operating cash in just the last two quarters. The key driver in the quarter was EBITDA totaling $32.1 million. All other operating balance sheet changes pretty much netted out during the quarter.

Investing cash flows included $2.4 million in capital spending and $8 million which we spent to buy out the minority interests held in our Japanese subsidiary, so let me explain that transaction for a minute. NEC and Sumitomo Electric each had held 20% interest in this subsidiary and had some spin-off. With the acquisition of TDK and a large Japanese presence of this brand, it made sense to fully own our results in Japan. We worked on and completed that transaction during the first quarter.

Finance and cash flows included $19.4 million, which we spent to repurchase about 830,000 shares of common stock under our share authorization which stands at 2.6 million shares remaining as of the end of the quarter.

In addition, we spent $31.3 million in the quarter paying off the notes associated with our purchase of the Memcorp business last year. We did this to lower our overall finance costs as the cost of this debt was relatively high.

Finally, we paid out $6 million for dividends during the quarter. As a result of this activity, cash and equivalents ended the quarter at $105.5 million, down $30 million in the quarter with the key driver being the payoff of the Memcorp notes that I just discussed.

Our outlook for 2008 remains unchanged from the guidance we provided coming out of 2007. We're targeting approximately $2.4 billion in revenues for '08, representing year-over-year growth of about 16%. 2008 operating income is targeted between $95 million and $105 million on a GAAP basis. That includes restructuring and other charges estimated in the range of $4 million to $6 million. Excluding those charges, operating income then is targeted in the range of $100 million to $110 million for the year.

Diluted EPS targeted between $1.51 and $1.68 per share for the year. That includes an approximate $0.08 impact from restructuring and other charges. Excluding those charges, EPS then is targeted between $1.59 and $1.76 per share. This outlook is based on our year end diluted shares outstanding of $38.5 million. The factors impacting the actual shares outstanding for this year, 2008, will include our share buyback levels and the dilutive impact of options and other equity awards, which are in part influenced by stock price levels.

As a final comment in our outlook, I want to reiterate something I mentioned last quarter. The seasonality of our business has clearly changed with the addition of more consumer based business especially the Memcorp consumer electronics business. As a result, the second half of the year will clearly be stronger than the first half, quarter four will be our strongest quarter followed by quarter three with Q2 typically our seasonally softest quarter of the year.

In summary, we're pleased with our start to our year especially in light of the economic conditions we faced in our businesses. We were encouraged by the resiliency of the business and very pleased with the strong cash flows and look forward to the rest of 2008 as we complete the acquisition integration and continue implementing our long term strategy.

At this point, Frank and I'd be pleased to take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mark Miller with Brean Murray.

Mark Miller - Brean Murray, Carret & Co.

Good morning Frank and Paul.

Frank Russomanno

Good morning Mark.

Paul Zeller

Good morning Mark.

Mark Miller - Brean Murray, Carret & Co.

Hi, just had a question. As you say, you seem bullish on the second half of the year and that's typically been the case. Fourth quarter is very strong for you. Is this because of your international exposure because a lot of visibility is pretty clouded about what's going on in the US?

Frank Russomanno

Mark, this is Frank. I'll start with that and then I'll let Paul jump in. I think it's for several reasons but the main reason is that based on the business that we have and the nature of the business we have today, we just know the seasonality is back end loaded and in particular it's the third and fourth quarters. To be more specific it's really in the months of September, October, and November. That's one.

Two is we do have a very good global business and as you saw, 61% of our sales are outside of the US today and we have opportunities especially in the consumer electronics business to try to strengthen our sales position outside the United States with those products. So to your point, you pretty much answered part of it, that it's not just the US but it's also our ability to reach outside.

Paul?

Paul Zeller

Mark, I'd just add that there was a couple of other earnings related factors that are a bit back end loaded. First is that our synergy work associated with the acquisitions will really be completed as we get into third and fourth quarter and then secondarily our restructuring program in manufacturing is also more impact full in the second half of the year than in the first half.

Mark Miller - Brean Murray, Carret & Co.

Just one other question. Did you say that the SG&A expenses will decline in terms of dollars and also as a percentage or just as a percentage as the year goes on to sales?

Paul Zeller

It should decline both in dollars and as a percent over time. Any given quarter, there's going to be variability quarter-by-quarter depending on seasonality and spending programs. As you know we are spending incrementally to a degree on integration as well as brand building and that can be not always perfectly even but as a general statement, we should be lowering our dollars and percent to sales over time.

Mark Miller - Brean Murray, Carret & Co.

And you expect R&D to be basically fairly flattish?

Paul Zeller

Yeah, I think we're at a good run rate on R&D right now.

Mark Miller - Brean Murray, Carret & Co.

Thank you.

Bradley Allen

Next question please.

Operator

Our next question comes from Glenn Hanus with Needham.

Glenn Hanus - Needham & Company

Good morning.

Frank Russomanno

Good morning Glenn.

Paul Zeller

Good morning Glenn.

Glenn Hanus - Needham & Company

Could you talk a little bit more on the tape side? Refresh me how much of your media is generally sold with new libraries versus the install base and then just any more color you can give on where the softening in demand is in tape and your view on how that's going to continue and play out.

Paul Zeller

Okay, to answer the first part about how is it sold, new media versus I guess you would say 'attached rate', for let's say, new drives versus old drives. My estimate would probably be 60% or so, maybe 65% is existing business and about 35% to 40% would be the new attach rates but you really got to dig beneath that and go a little deeper, because that would not be the case with 9840, 9940 but it would be the case obviously with a T10000. T10000 would be just the opposite, probably predominately all new installations as compared to some additional orders beyond that.

So that issue is, that's an issue that we don't spend a lot of time, we spend more of our time talking about the attach rate per drive out there and try to flatten it out over a period. But we do talk to the OEMs about what their new drive sales are expected to be and our experience has been its typically higher than it actually turns out to be.

Glenn Hanus - Needham & Company

Yeah, I was just wondering whether this was more tied to slower library sales in the first quarter and the existing business was fine or what's that…

Paul Zeller

I don't think it was as much tied to slower library systems or especially big systems, because this was more of a slowdown in the data center where there are going to be very large systems at stake. When we look at our customer base, if you look at our verticals one of the most important vertical we have is the financial institutions and that clearly was soft.

Another key vertical for us is the oil business and that vertical was not soft like that. We just know that by the virtue of the products they buy and secondly because at that End User Council we just left just a little while ago. So what we're looking for is some of this business to come back and the big question is how much of it will be coming back and when?

Glenn Hanus - Needham & Company

Okay, thank you.

Bradley Allen

Okay, next question Kevin.

Operator

Our next question comes from Matt Teplitz with Quaker.

Matt Teplitz - Quaker Capital Management

Hi, good morning gentlemen.

Frank Russomanno

Good morning Matt.

Matt Teplitz - Quaker Capital Management

Good morning. A couple quick questions, sort of following on Glenn's question because it still seems a little not clear to me. Sir, are you saying that to some extent even on a fair bit of your install base you were seeing lower orders where, which seems a little strange to me. I guess people might carry a little less inventory but I mean, did they generate data they need to save or back it up. So I just want to make sure I was clear on that?

Frank Russomanno

Well, to the best of our understanding, the answer to the first part of your question is yes. In the financial services sector, which I identified as one of the biggest ones and I think that's because there was a choice, to a degree, of discretionary spending of some level which they deferred into later quarters and we'll have to see if that's correct and if so to what degree?

Paul Zeller

Matt, one of the things we have, we believe and have affirmed by these discussions is that the data continues to grow and it needs to be backed up and archived and so it supports our belief that while you can delay your spending for a period of time, it eventually needs to come. The data is there. It does need to be dealt with and backed up and that kind of annuity model is a real big positive in our business.

Frank Russomanno

For us it's not an issue of having lost share because so many of those key products, unlike LTO, are proprietary products. So it's not a share loss issue, it's a matter of spending or not spending in that financial sector.

Matt Teplitz - Quaker Capital Management

Okay. But can you …

Frank Russomanno

Does that help you any, Matt?

Matt Teplitz - Quaker Capital Management

Yeah, I guess what I'm trying to understand, does that mean there's a marginal drive they don't install or does that mean they just carry fewer pieces of tape on the shelf in their…?

Frank Russomanno

I believe Matt, first of all, just about all of our customers have very little inventory.

Matt Teplitz - Quaker Capital Management

Right.

Frank Russomanno

They buy and use. I mean, they're just not stocking tape but I believe there is probably a little bit of pent up demand on both, that they haven't done all the drive installations and haven't made all the changes yet so there's a piece there. And the other piece is those who have the drives in place have not continued to buy more tape yet, so it's a combination. I don't think it's one or the other.

Matt Teplitz - Quaker Capital Management

Okay, on the whole sort of mid range DLT and LTO, any feel for what's going on there and new drive adoption, market share, anything you can say there?

Frank Russomanno

LTO-4 continues to grow. LTO-2 and 3 are still relatively strong and we had growth in the LTO product line this quarter.

Paul Zeller

I think if you think about the other key element there which is the pricing reality and what goes on there in that environment, you may remember some of the issues we faced last year. I think we had a pricing environment about what we expected, much more stable in LTO-1 and 2, moderating on LTO-3 and continuing in the typical fashion for a newer product in LTO-4. So I think aggressive pricing as expected in LTO-4 and where it should be on the other formats as well.

Matt Teplitz - Quaker Capital Management

One other question about pricing and over the years I think it's always been kind of difficult to predict when and where your Japanese competitors might get aggressive on price, but are you seeing any difference in their behavior given the appreciation of the Yen. Has that had any [adverse] impact?

Frank Russomanno

Not at all, Matt.

Matt Teplitz - Quaker Capital Management

Okay so we can always hope but probably shouldn't expect it.

Frank Russomanno

Not at all. The fundamental issue here is there are five people in the business.

Matt Teplitz - Quaker Capital Management

Right.

Frank Russomanno

…excess capacity, and as a general comment, our Japanese competitors have not lost these industries. I mean, they're in this business.

Matt Teplitz - Quaker Capital Management

Okay.

Frank Russomanno

So what we have to do, this is the important point though. What we have to do is recognize that fact and deal with it and part of the way we dealt with it last year was to restructure when we announced the movement of our site for converting tape to Mexico to gain some advantage again to maintain margin. That's a fact, so that's what happens.

Last point Matt, I want to go back to that data center issue, because that's a really critical point and I'm glad you and Glenn keep pushing us on that issue. It's one that we're watching very carefully. It's one where we've gone out and reached out to end users to try to get some feedback and then I mentioned the End User Council.

What we learned to the best of our ability of what we heard and what they told us is that there was deferral of spending in the first quarter, but no one clearly said all those funds are going to be released. And by the way, once again we went to the financial segment in particular because that's where most of these comments were made.

So we're going to have to see if we see improvement in Q2 and if not in Q2, the back end of the year. But as Paul was describing, all that work that needs to be done to move data off site and put into archival storage is still there. As that work hasn't gone away. The businesses continue to generate more data and they are trying to make do as best they can but they were asked to curtail their spending in the financial sectors.

Paul Zeller

Matt, if I could follow-up on one point back on midrange and I think it's an important point, which is the combination of the actions we're taking on the cost side with the restructuring and pricing being kind of where it is expected to be, we saw some nice improvements in margins in the midrange. It's been encouraging that quarter-after-quarter we've been slowly bringing up the margin in midrange as we get more and more of a mix of LTO-4, as that gets to be a bigger and bigger part of the equation, as we continue to lower our costs with the actions around converting, so I think it's been we're working our plan and it's going successfully still.

Frank Russomanno

Matt, the reason why we believe we're doing better not only because of the restructuring announcement, it goes back to our R&D capabilities where we were not linked to market. The best way to make market in LTO is to be first to market or among the one or two companies who get out there with the product that's qualified in some type of volume, because you know the price curve after that comes down relatively quickly.

Matt Teplitz - Quaker Capital Management

All right, just one quick sort of last point on this whole issue of sort of data center spend and particularly I guess in the financial service industries. Your guidance for the year, what assumption does that make relative to I guess a bounce back in that business or versus first quarter results?

Paul Zeller

I think it's fair to say our outlook from the beginning of the year and our comments about maintaining it at this point in time have always had some degree of caution relative to the economic realities we're facing as an overall contextual statement, alright? When it comes to data center and tape specifically, we do expect a reasonable level of business to continue for the rest of the year. We don't expect every quarter to be as it was in first quarter.

We're not assuming an immediate bounce back. I think it's reasonable to assume that the demand will pick back up over some period of time. Whether it happens exactly and what stage, we have a range in our outlook for those kinds of reasons. There's lots of factors we consider in looking at the outlook. I think we're very comfortable with the discussion we've had with the End Users who are very close to the situation and I think we're confident in our outlook.

Matt Teplitz - Quaker Capital Management

Okay good. Just few other quick questions. You guys obviously got some improvement in your working capital management in the first quarter and I know that was a focus. How much, where are you relative to where you want to be in terms of whether it's appropriate DSO level, appropriate inventory level, can you talk about it?

Paul Zeller

If you look at our day's sales outstanding and days of inventory, I mean first quarter is going to be a good cash flow quarter, because you're in a sense collecting off the receivables and working capital from the really big fourth quarter coming into first quarter.

So let's separate the good job of kind of pulling the cash flow out of that strong fourth quarter from the actual indices themselves which really weren't improved from fourth quarter to first quarter and actually they're about flat when you consider the whole cash-to-cash cycle. If you put payables into the mix as well which is the way we really look at it. It's about 69, 70 days at fourth quarter and the same number at first quarter.

I think we clearly have some room to improve from there and it's not just on one part of that. I think receivables is a bit more what it's going to be. The mix is an impact there as we grow more in consumer. Those terms could tend to be a bit longer than maybe on the commercial side, but then we continue to work it and try to improve it but on the inventory and payables side, we think there's some real opportunity there.

We have a pretty strong position in some of our markets with the acquisitions we've made and the number of brands we have and the share we have and I think we can continue to use that to our benefit and improve overall terms and overall working capital. So we clearly have our goals to improve from where we're at.

Frank Russomanno

Hey Matt, this is Frank. One more thing on that, I'm glad you noticed the improvement and that improvement didn't come by accident. I think you remember in August in our third quarter call we talked about appointing Pete Koehn who was formerly our Corporate Controller to lead Global Operations for the company. There has been significant progress made by that team but we're pushing them pretty hard to do a lot more and I think we see the improvements in multiple ways including in the sourcing area and how we're managing our capital. It's just totally improved so I do want to tell you that. It's not just a focus per se. It's really individual leadership and very close management too.

Matt Teplitz - Quaker Capital Management

How long do you think it should take to get closer to where you want to be particularly on the sort of inventory and accounts payable positions?

Paul Zeller

Well, I don't think we'll ever be satisfied with it being good enough. So I think we're always going to be working on it, but I'd say this year is going to be a year where we really implement a lot of these things that Pete and his organization are working on and if we're successful, it could be a year where we start to see some of those improvements. I wouldn't say it's any one quarter. I'd say it's kind of a continuous improvement kind of philosophy and I just think whether it's spending or working capital management, it's never enough and you keep working it.

Matt Teplitz - Quaker Capital Management

Okay, one last question just to clarify your earlier, actually maybe two questions, but clarify your earlier response regarding SG&A. It sounds like, is Q1 effectively the high water mark for the dollars this year in SG&A, unless there was to be some sort of one time charge not currently anticipated?

Paul Zeller

What I'd say Matt is that some of that is going to be dependent on translation rates and where the dollar goes…

Matt Teplitz - Quaker Capital Management

Right, okay that's fair.

Paul Zeller

So if the dollar were to get a lot weaker even from where it's at, there's always…

Matt Teplitz - Quaker Capital Management

Well, assuming flat currency from here.

Paul Zeller

Then I'd say as you get past Q2 it should clearly go down. Whether Q2 is lower than Q1 I think is a bit of an open question, but as you progress throughout the year, it clearly should be coming down, because in third quarter, we really start getting some benefits from the acquisition synergy work and a lot of that is tied around IT systems work which, I mean, you can't deal with your structure until you have kind of the systems side completed and those things are targeted for third and fourth quarter in Europe and in Japan. And then tied into that are that some of the manufacturing moves we're making are also tied into the second half of the year. So the statement I made is a bit more second half than second quarter.

Matt Teplitz - Quaker Capital Management

And just as it [regards] to the amortization expense that flows through your income statement, how does that fall out between costs of goods, SG&A?

Paul Zeller

It's an SG&A charge really.

Matt Teplitz - Quaker Capital Management

Okay so most, so that's obviously in play in your SG&A number pretty dramatically then.

Paul Zeller

Sure, that is definitely a year-over-year impact for sure as you look at quarter one to quarter one.

Matt Teplitz - Quaker Capital Management

Okay and this is the last question then. Obviously you guys are cleaning up the balance sheet. The debt is down. You bought in stock again, looks pretty steady. What's sort of a comfort level on your cash and is it likely that the share buyback essentially will be funded to the extent that there is free cash from operations?

Paul Zeller

When it comes to the exact cash balance, that's not something that's a specific target. I mean, we're not going to target this cash balance or that cash balance. I think there's a broad capital structure that we've obviously made more efficient over time as we deployed the cash through the strategic acquisitions. The precise amount of and strategy around share repurchase is something that will be quarter-by-quarter and something that we'll talk to you about as we do it at the end of the quarter.

Frank Russomanno

Let me say something else about share buyback though. First of all I want to commit again that we remain committed to take out the dilution of the TDK acquisition. That has not changed. You saw that we've purchased another 830,000 shares at about $19.4 million. We're repurchased about 70% of the dilution from the TDK dilution. We've repurchased that so we remain committed to taking out that TDK dilution and Paul has explained to you how we intend to do it and what our strategy is there.

Matt Teplitz - Quaker Capital Management

Yeah, and just I had one question. Given your standstill with TDK and I guess whatever your and their comfort is as to what percentage of the company they might hold. Does that effectively limit share buyback or would they participate in selling shares to you? How would that work?

Paul Zeller

In the actual agreement with TDK, there's some provisions related to their ownership. First of all, they are precluded from acquiring actively greater than 21% ownership in the company. We believe and they have made the statement that they do own around 20% of the company at this stage. As we buy back shares of course their ownership increases, so there's a separate provision in the agreement which essentially allows us to keep them from getting past 22% ownership passively as we acquire shares. So essentially there would be a process of keeping them from going past 22% passively.

Matt Teplitz - Quaker Capital Management

Okay, so does that effectively sort of claw the shares back from them?

Paul Zeller

Yeah, effectively, yeah.

Matt Teplitz - Quaker Capital Management

Okay, well thank you. Sorry for monopolizing the call.

Paul Zeller

No problem.

Frank Russomanno

Good questions Matt.

Bradley Allen

Next question Kevin.

Operator

Our next question comes from Mark Miller with Brean Murray.

Mark Miller - Brean Murray, Carret & Co.

Just playing with my model here, especially if SG&A kind of comes down after this quarter. Do you feel that the margins in the current quarter are sustainable or are we going to see lower margins as we go into the year?

Paul Zeller

Mark, I think you'll see lower margins throughout the rest of the year. We had a lot of things going for us in the first quarter not the least of which is mix. Also currency, and some really good execution on our gross margins in Optical and Flash. I think the guidance we kind of gave coming out of last year end to see a gross margin in and around the level we saw for full year '07, say 17% to 17.5% is probably a better range to assume for the rest of the year and I just think that it would be a little optimistic to assume we're going to keep the 18.5% level for the rest of the year.

Mark Miller - Brean Murray, Carret & Co.

Okay, thank you.

Paul Zeller

You bet.

Operator

Our next question comes from Glenn Hanus with Needham.

Glenn Hanus - Needham & Company

That was my question. The stock comp, is that running about $3 million a quarter and is that about what you expect there?

Paul Zeller

Yeah, it's about there, maybe just a little bit less, 2.8, I don't know, 2.7, 2.8 I think, but very similar and the same sort of distribution between SG&A and other lines.

Glenn Hanus - Needham & Company

And that's about where it will stay?

Paul Zeller

Yeah, I don't see that changing significantly.

Glenn Hanus - Needham & Company

And how about on the Memcorp? Can you talk a little bit more there about what's sort of the core growth rate of that business? How do I model that going forward and what were the issues there or was it just seasonality?

Paul Zeller

That's a really good question, Glenn. There's a real interesting opportunity with that business. We see the channels in the US and really everywhere, outside the US it's very underpenetrated with the Memorex brand and CE and we see a great opportunity. So to speak to what kind of normalized growth rate is, is when you're at a smaller share as this brand is and already a $200 million and growing business. I think it's hard to sort of model it that way.

I think we have a lot of aggressive plans and what we can do with this business. We'll have to prove we can execute on those quarter by quarter. So I think it's a little hard to kind of think about an industry growth rate or I mean, obviously CE in general in a lot of categories is growing very nicely, but the bigger opportunity for us is that it's a big opportunity and there's a lot of places we can go we believe with this brand.

Frank Russomanno

I wanted to make a comment about this. Glenn, if you may or may not know but this piece of the business still reports directly to me and the reason it does, we wanted to be able to manage it very carefully especially this first year and when we think about this business, I mentioned earlier in the comments about some initiatives for growth, this is one of the key initiatives for growth and when we look at the initiatives in this consumer electronics piece, we see three segment areas for growth.

Number one is greater penetration in the channels in the US and we can do that by the way, in both consumer and B-to-B channels. Some of the products that are offered in that CE line also have a fit in the commercial business. So one is channel expansion in the US.

Number two is expansion outside of the US and we've had success, preliminary as it is, in both Mexico and Canada with Wal-Mart and we've also had success with Future Shop in Canada, which is the same Best Buy outlet, as well as also in Panama. So we're starting to see a Latin America presence and that's the way we're going to try to move. We're going to move across the United States and then into Latin America and Canada simultaneously and then look for opportunities outside of that. So the second opportunity is OUS growth.

Then last but not least is the Nickelodeon product line. So this CE business has tremendous amount of opportunity for us and that's why it's really difficult for us to put a real growth rate on that per se. So it's one that we'll be able to talk about better in the second quarter than we are right now, where we expect seasonally to be stronger in Q2 than we were in Q1, and we're very optimistic about…

Glenn Hanus - Needham & Company

What were revenues last year? Can you refresh me on that, for that business?

Paul Zeller

Well, it was a partial year for us in terms of CE and the revenues and so it's…

Frank Russomanno

It's in the range of $200 million.

Paul Zeller

If you would normalize it, if you'd normalize it.

Frank Russomanno

If you'd normalize, it was about 200.

Glenn Hanus - Needham & Company

So it's about a $200 million business and you did $26 million this quarter so are we going to see rapid growth going, sequential growth, is this going to be sort of the $200 millionish business this year or way down or…?

Paul Zeller

I think it clearly could be more than that and I think its, quarter one will always be a quite small part of the total year. You could see approaching two-thirds of the year in the second half. At least 60%, 65% for sure will be second half versus first half so the first quarter revenues don't tell a lot about the story of this business.

Frank Russomanno

When we succeed on our strategies, you'll see a lot of the sales in the third and fourth quarters and in particular the months of September, October, and November because you have to move that type of equipment into the stores before the Christmas season. There's not a lot of shipments in December.

Glenn Hanus - Needham & Company

Thank you.

Frank Russomanno

Thank you.

Operator

There are no further questions at this time.

Frank Russomanno

Okay, I'd just like to wrap up relatively quickly by first of all thanking everyone for being on our call here today, remind you about our shareholder meeting on May 7th in New York City at the Hotel Sofitel. We do hope to see a lot of you there and leave you with these final thoughts. That we're pleased with the earnings in the quarter especially in today's economic environment. We're pleased with the progress of our transformation both with our acquisitions and the re-skilling that's taking place in the company, and last but not least we remain committed to our 2008 financial targets and we look forward to talking to you during the quarter or at our next Analyst meeting. Thank you very much for attending.

Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect.

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